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MBEC 6001 Pre-MBA Economics L1(1) (1) (5 files merged).pdf

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MBEC 6001 Pre-MBA Economics L1(1) (1) (5 files merged).pdf

  1. 1. MBEC 6001 Pre-Economics L1: Principles of Economics
  2. 2. Lecture Outline • Introductions & ice- breakers • Course Outline & Assessments • Class Rules & Contact Details • Introduction to Principles of Economics
  3. 3. Course Outline • Understanding Individual Markets (The Price System) • Consumer Behaviour and Utility Theory • Public Goods, public expenditures & Common Resources • The Costs of Production • Price and Output Determination / Profit Maximizing Decision in Different Market Structures • Macroeconomic Goals and Measures • Fiscal Policy and Macroeconomic Issues • Monetary Policy and Macroeconomic Issues
  4. 4. Principles of Economics
  5. 5. What is Economics? • “Economics is a study of mankind in the ordinary business of life” Alfred Marshal
  6. 6. The Basic Economic Problem • Society’s resources are limited or scarce • The scarcity of society’s resources means that it cannot produce all the goods and services people wish to have • How can we solve this problem?
  7. 7. What is Economics? • Economics is the study of how society manages its scarce resources. • Two implicit assumptions: 1. People have unlimited wants, but limited resources 2. Everything has a cost Scarcity Decision making Efficient allocation of resources
  8. 8. Thinking Like an Economist • Economists apply a set of concepts and principles to understand everyday life around them How the Economy Works as a Whole How People Interact How People Make Decisions
  9. 9. Principle 1: People Face Trade-Offs • Making decisions requires trading- off one goal against another Ø To get one thing, we have to give up another thing in return • Examples of Trade-offs: Ø How a students decides to allocate her time: Studying vs. Watching something on Netflix ØHow a family decides to spend their income: Food vs. clothing vs. schooling ØHow a government decides to spends it budget: Healthcare vs. Defence
  10. 10. Principle 2: The Cost of Something is What you Give Up to Get It • Because people face trade-offs, making a decision requires comparing the costs and benefits between alternative courses of action The opportunity cost of an item is what must be given up to obtain it • The opportunity cost of something can be monetary (e.g. forgone money) or non-monetary (e.g. time)
  11. 11. Exercise: Would you rather….? Trade-Offs & Opportunity Cost • Which of the following would you rather choose? What is the true cost of making your choice? 1. Going to the cinema with friends next Thursday night or studying for an exam 2. Earning a university degree or getting a job 3. Depositing $100 in an interest-bearing savings account or spending it on a new pair of shoes When making a choice, the opportunity cost is given by the next-best alternative.
  12. 12. Principle 3: Rational People Think at the Margin • For Economists, rational people are those that systematically and purposefully do the best they can to achieve their objectives, given available opportunities. • Economists use marginal change to describe a small, incremental adjustment to an existing plan of action. ØE.g. An extra hour of studying instead of watching Netflix Rational people often make decisions by comparing marginal benefits vs. marginal costs. Marginal Benefit Marginal Cost
  13. 13. Exercise: Marginal Decision Making • Suppose that the company you manage invested SR 5 Million in developing a new product, but the development is not quite finished. At a recent meeting, your sales executive reported that the expected sales of your new product has been reduced to SR 3 Million as your competitors have introduced a similar product. At the same time, it would cost your company another SR 1 Million to finish the development of your product. • Based on your understanding of marginal decision making, discuss whether you should complete the development of this product. If so, what is the most you should be willing to pay to complete the development? Explain your reasoning.
  14. 14. Letting Go of Sunk Costs.. • Sunk cost: A cost that has already been committed and cannot be recovered • Sunk costs should be irrelevant to decisions; you must pay them regardless of your choice.
  15. 15. Principle 4: People Respond to Incentives • An incentive is something that induces a person to act ØAn incentive can be positive (i.e. reward) or negative (i.e. punishment) • Incentives are crucial to analysing how markets work ØI.e. Price incentives influence the behaviour of consumers and producers and the outcomes of markets • Incentives are important to consider when designing new policies
  16. 16. Exercise: Understanding Incentives & Human Behavior • What incentives & desired behaviors are being presented in each of the following?
  17. 17. Thinking Like an Economist • Economists try to address problems with a scientist’s objectivity • Economists make assumptions to simplify complex real-world events –Beware of over-simplifying assumptions!
  18. 18. The Tools of Economics Economic Analysis Mathematics Words Diagrams
  19. 19. Microeconomics vs. Macroeconomics Microeconomics • The study of how individual households and firms make decisions and how they interact with another in markets Macroeconomics • The study of the economy as a whole i.e. how economic changes affect many households, firms and markets simultaneously
  20. 20. Positive vs. Normative Positive • What is? • Not based on value judgements Normative • What should to be? • Based on value judgements
  21. 21. MBEC   6001   Pre-­‐Economics L2:  Understanding  Individual  Markets  &  The  Price   Mechanism   The  Market  Forces  of  Supply   and  Demand
  22. 22. What  is  a  Market? • In  a  market,  buyers as  a  group  determine  the  demand for  the   product  &  sellers as  a  group  determine  the  supply of  the  product   • When  buyers  and  sellers  interact  in  a  market  place,  the  price  and   quantity of  goods  and  services  are  determined   • Markets  can  be  highly  organized  or  less  organized   A  market is  a  group  of  buyers  and  sellers  of  a  particular  good  or   service  
  23. 23. DEMAND  
  24. 24. Demand   • The  QUANTITY  DEMANDED  of  a  good  is  the   amount  of  the  good  that  buyers  are  willing  and   able  to  purchase. • The  quantity  demanded  of  a  good  will  be   influenced  by  many  factors,  but  the  most   important  factor  is  its  price THE  LAW  OF  DEMAND: Other  things  equal,  when  the  price  of  a  good   rises,  the  quantity  demanded  of  the  good falls  and  when  the  price  falls,  the  quantity   demanded  rises.   The  quantity  demanded   is  negatively  related to   the  price.  
  25. 25. The  Demand  Schedule   • A  DEMAND  SCHEDULE  is  a  table  that   shows  the  relationship  between  the   price  of  a  good  and  the  quantity   demanded. • E.g.  Coffeeholic’s demand  for  lattes   • Holding  constant  everything  else  that   may  influence  how  many  lattes   Coffeeholic wants  to  buy,  the  demand   schedule  shows  that  his/her   preferences  OBEY  THE  LAW  OF   DEMAND   Price   of  lattes Quantity   of  lattes   demanded $0.00 16 1.00 14 2.00 12 3.00 10 4.00 8 5.00 6 6.00 4
  26. 26. $0.00 $1.00 $2.00 $3.00 $4.00 $5.00 $6.00 0 5 10 15 Price  of   Lattes Quantity  of   Lattes The  Individual  Demand  Curve Price   of  lattes Quantity   of  lattes   demanded $0.00 16 1.00 14 2.00 12 3.00 10 4.00 8 5.00 6 6.00 4 The  DEMAND   CURVE  is  a  graph  of   the  relationship   between  the  price   of  a  good  and  the   quantity   demanded.   A  demand  curve  is   always  downward   sloping.  
  27. 27. Market  Demand  Vs.  Individual  Demand 4 6 8 10 12 14 16 Coffeeholic’s Qd 2 3 4 5 6 7 8 Latteholic’s Qd + + + + = = = = 6 9 12 15 + = 18 + = 21 + = 24 Market  Qd $0.00 6.00 5.00 4.00 3.00 2.00 1.00 Price   • The  MARKET  DEMAND  CURVE  shows  how  the  total  quantity  demanded  of  a  good  varies  as  the   price  of  the  good  varies,  while  all  other  factors  are  held  constant.   • The  market  demand  curve  is  the  SUM of  all  individual  demands  for  a  particular  good.   Assuming   Coffeeholic &   Latteholic are  the   only  buyers  in  the   market,  the  market   demand  is  the  sum   of  the  quantities   demanded  (Qd)  by   them  at  each  price.  
  28. 28. $0.00 $1.00 $2.00 $3.00 $4.00 $5.00 $6.00 0 5 10 15 20 25 P Q The  Market  Demand  Curve  for  Lattes P Qd (Market) $0.00 24 1.00 21 2.00 18 3.00 15 4.00 12 5.00 9 6.00 6 A  Change  in  the   price  of  lattes   causes   movements   along  the   demand  curve   (e.g.  a  decrease   in  the  price  from   $3  -­‐ $2  will  cause   an  increase  in   demand  from   15-­‐18).  
  29. 29. Shifts  in  the  Demand  Curve   • The  demand  curve  shows  the   quantity  demanded  at  any  given   price,  other  things  being  equal   (ceteris  paribus).   • These  “other  things”  are  non-­‐price   determinants that  may  alter   demand  (e.g.  income,  tastes,   expectations) • A  change  in  any  of  these   determinant  will  cause  SHIFTS in   the  demand  curve   Ø Changes  that  lead  to  an  INCREASE  in   demand  à Shift  the  D-­‐curve  RIGHTWARDS   Ø Changes  that  lead  to  a  DECREASE  in  demand   à Shift  the  D-­‐curve  LEFTWARDS  
  30. 30. $0.00 $1.00 $2.00 $3.00 $4.00 $5.00 $6.00 0 5 10 15 20 25 30 P Q Suppose  the  number  of   buyers  increases.     Then,  at  each  P,   Qd will  increase   (by  5  in  this  example). Demand  Curve  Shifters:   #  of  Buyers An  increase  in  the  number  of  buyers,   increases  the  quantity  demanded  at  each   price.  This  leads  the  D-­‐curve  to  shift  to  the   right.  
  31. 31. Demand  Curve  Shifters:   Income • The  effect  of  change  in  income  on  demand      depends  on   the  type  of  good: Normal  Good   • Demand  for  a  normal  good  is   positively  related  to  income. • An  increase  in  income  increases the  quantity  demanded  at  each   price.  This  leads  the  D-­‐curve  to   shift  to  the  right.   Inferior  Good   • Demand  for  an  inferior  good  is   negatively  related to  income. • An  increase  in  income  decrease the  quantity  demanded  at  each   price.  This  leads  the  D-­‐curve  to   shift  to  the  left.
  32. 32. Demand  Curve  Shifters:  Prices  of  Related   Goods     • The  relationship  between  two  goods  can  be  described  as   being  substitutes  or  complements:   • Two  goods  are  substitutes  if  an   increase  in  the  price  of  one   causes  an  increase  in  the   demand for  the  other.     Substitutes   • Two  goods  are  compliments  if  an   increase  in  the  price  of  one   causes  a  fall  in  the  demand for   the  other.     Complements  
  33. 33. Exercise:  Relationships  between  Goods   • EXERCISE:  If  an  increase  in  the  price  of  mangoes  leads  to  an  increase   in  the  demand  for  pineapples,  then  mangoes  &  pineapples  are: A. Complements B. Substitutes   C. Normal  Goods   D. Inferior  Goods  
  34. 34. Demand  Curve  Shifters:  Tastes • Anything  that  causes  a  shift  in  tastes  toward  a  good  will  increase   demand  for  that  good  and  shift  its  D-­‐curve  to  the  right. • Examples: ØAs  kale  becomes  more  popular  for  healthier  eating  habits,  this   causes  an  increase  in  demand  for  kale,  which  shifts  the  kale   demand  curve  to  the  right.  
  35. 35. Demand  Curve  Shifters:  Expectations   • Expectations  affect  consumers’  buying   decisions  and  therefore,  their  demand  for   goods  and  services. • Examples:     ØIf  people  expect  their  incomes  to  rise,  their   demand  for  meals  at  expensive  restaurants  may   increase  now. ØIf  the  economy  is  in  a  downturn  and  people   worry  about  their  future  job  security,  demand   for  new  cars  may  fall  now.  
  36. 36. Summary:    Variables  That  Influence  Buyers Variable A  change  in  this  variable…   Price …causes  a  movement along the  D curve #  of  buyers …shifts the  D curve Income …shifts the  D curve Price  of related  goods …shifts the  D curve Tastes …shifts the  D curve Expectations …shifts the  D curve
  37. 37. Exercise:  Demand  Curve  Shifters   • EXERCISE:  Which  of  the  following  would  cause  a  decrease  in  the  demand  for   Shahid  subscriptions? A. An  increase  in  the  popularity  of Shahid-­‐produced  shows. B. An  increase  in  the  number  of  smart-­‐device  users.   C. A  decrease  in  household  disposable  incomes  (if  Shahid  is  a  normal  good). D. An  increase  in  the  price  of Netflix  subscriptions (if  Shahid  &  Netflix  are   substitutes).
  38. 38. SUPPLY
  39. 39. Supply   • The  QUANTITY  SUPPLIED  of  a  good  is  the   amount  of  the  good  that  sellers  are  willing  and   able  to  sell. • The  quantity  supplied  of  a  good  will  be   influenced  by  many  factors,  but  the  most   important  factor  is  its  price THE  LAW  OF  SUPPLY: Other  things  equal,  when  the  price  of  a  good   rises,  the  quantity  supplied  of  the  good rises   and  when  the  price  falls,  the  quantity   supplied  falls.   The  quantity  supplied  is   positively    related to  the   price.  
  40. 40. The  Supply  Schedule Price   of  lattes Quantity   of  lattes   supplied $0.00 0 1.00 3 2.00 6 3.00 9 4.00 12 5.00 15 6.00 18 • A  SUPPLY  SCHEDULE  is  a  table  that   shows  the  relationship  between  the   price  of  a  good  and  the  quantity  supply. • E.g.  Coffee  Bean’s  supply  of  lattes   • Holding  constant  everything  else  (ceteris   paribus)  that  may  influence  how  many   lattes  Coffee  Bean  wants  to  sell,  the   supply  schedule  OBEYS  THE  LAW  OF   SUPPLY  
  41. 41. $0.00 $1.00 $2.00 $3.00 $4.00 $5.00 $6.00 0 5 10 15 The  Individual  Supply  Curve Price   of   lattes Quantity   of  lattes   supplied $0.00 0 1.00 3 2.00 6 3.00 9 4.00 12 5.00 15 6.00 18 P Q The  SUPPLY  CURVE  is  a  graph  of  the   relationship  between  the  price  of  a   good  and  the  quantity  supplied.   A  supply  curve   is  always   upward   sloping.  
  42. 42. Market  Supply  Vs.  Individual  Supply • The  MARKET  SUPPLY  CURVE  shows  how  the  total  quantity  supplied  of  a  good   varies  as  the  price  of  the  good  varies,  while  all  other  factors  are  held  constant.   • The  market  supply  curve  the  SUM of    the  quantities  supplied  by  all  sellers at  each   price.   18 15 12 9 6 3 0 Coffee  Bean’s   Qs 12 10 8 6 4 2 0 Costa’s  Qs + + + + = = = = 30 25 20 15 + = 10 + = 5 + = 0 Market  Qs $0.00 6.00 5.00 4.00 3.00 2.00 1.00 Price   Assuming  Coffee   Bean  &  Costa  are   the  only  sellers  in   the  market,  the   market  supply  is  the   sum  of  the   quantities  supplied   by  them  at  each   price.  
  43. 43. $0.00 $1.00 $2.00 $3.00 $4.00 $5.00 $6.00 0 5 10 15 20 25 30 35 P Q The Market Supply Curve P QS (Market) $0.00 0 1.00 5 2.00 10 3.00 15 4.00 20 5.00 25 6.00 30
  44. 44. Shifts  in  the  Supply  Curve   • The  demand  curve  shows  the  quantity  supplied  at  any  given   price,  other  things  being  equal  (ceteris  paribus).   • These  “other  things”  are  non-­‐price  determinantsthat  may   change  supply  (e.g.  technology,  expectations) • A  change  in  any  of  these  determinant  will  causes  SHIFTS in   the  supply  curve: ØChanges  that  lead  to  an  INCREASE  in  supply  à Shift  the   S-­‐curve  RIGHTWARDS   ØChanges  that  lead  to  an  DECREASE  in  supply  à Shift  the   S-­‐curve  LEFTWARDS  
  45. 45. Supply  Curve  Shifters:    Input  Prices • Examples  of  input  prices:     wages,  prices  of  raw  materials. • A  fall in  input  prices  makes  production  more   profitable  at  each  output  price,  so  firms  supply   a  larger  quantity  at  each  price,  and  the  S-­‐ curve  shifts  to  the  right.  
  46. 46. $0.00 $1.00 $2.00 $3.00 $4.00 $5.00 $6.00 0 5 10 15 20 25 30 35 P Q Supply Curve Shifters: Input Prices Suppose  the  price  of   milk  falls.  Then,  at   each  P,   Qs of  lattes  will   increase   (by  5  in  this   example). An  fall  in  input  prices,   increases  the  quantity   supplied  at  each  price.   This  leads  the  S-­‐curve  to   shift  to  the  right.  
  47. 47. Supply  Curve  Shifters:    Technology • Technology  determines  how  much  inputs   are  required  to  produce  a  unit  of  output.     • A  cost-­‐saving  technological  improvement   has  the  same  effect  as  a  fall  in  input   prices,  which  leads  the  S-­‐curve  to  shift  to   the  right.    
  48. 48. Supply  Curve  Shifters:    #  of  Sellers     • An  increase  in  the  number  of   sellers  increases  the  quantity   supplied  at  each  price,  shifts   the  S-­‐ curve  to  the  right.  
  49. 49. Supply  Curve  Shifters:    Expectations   • In  general,  sellers  may  adjust  supplywhen  their   expectations  of  future  prices  change.     Examples: • If  sellers  expect  the  price  of  coffee  beans  to  rise   in  the  future,  they  will  put  some  of  their  current   production  into  storage  and  supply  less  to  the   market  today,  which  shifts  the  S-­‐curve  to  the   left.    
  50. 50. Summary:    Variables  that  Influence  Sellers Variable A  change  in  this  variable…   Price …causes  a  movement along the  S curve Input  Prices …shifts the  S curve Technology …shifts the  S curve #  of  Sellers …shifts the  S curve Expectations …shifts the  S curve
  51. 51. Exercise:  Supply  Curve  Shifters   • EXERCISE:  Which  of  the  following  would  cause  the  supply  of  manufactured   clothing  to  increase? A. An  increase  in  the  cost  of  raw  materials. B. An  improvement  in  manufacturing  technology.   C. A  decrease  in  the  number  of  clothing  manufacturers.   D. An  increase  in  the  wages  of  workers  employed  in  clothing  factories.  
  52. 52. DEMAND  &  SUPPLY  
  53. 53. The  Law  of  Demand  vs.  Supply THE  LAW  OF  DEMAND: Other  things  equal,  when  the  price  of  a   good  rises,  the  quantity  demanded  of  the   good falls  and  when  the  price  falls,  the   quantity  demanded  rises.   THE  LAW  OF  SUPPLY: Other  things  equal,  when  the  price  of  a   good  rises,  the  quantity  supplied  of  the   good rises  and  when  the  price  falls,  the   quantity  supplied  falls.  
  54. 54. Variables  that  Influence  Demand  vs.  Supply
  55. 55. Terms  for  Shifts  vs.  Movements  Along   Curves • Change  in  supply: A  shift in  the  S curve occurs  when  a  non-­‐price  determinant  of  supply  changes  (like   technology  or  costs).   • Change  in  the  quantity  supplied: A  movement along  a  fixed  S curve  occurs  when  P changes.     • Change  in  demand: A  shift in  the  D curve  occurs  when  a  non-­‐ price  determinant  of  demand  changes  (like  income  or  #  of   buyers). • Change  in  the  quantity  demanded:A  movement along  a  fixed   D curve  occurs  when  P changes.  
  56. 56. $0.00 $1.00 $2.00 $3.00 $4.00 $5.00 $6.00 0 5 10 15 20 25 30 35 P Q Putting  Supply  and  Demand  Together D S Equilibrium:     P has  reached   the  level  where   quantity  supplied   equals quantity  demanded  
  57. 57. D S $0.00 $1.00 $2.00 $3.00 $4.00 $5.00 $6.00 0 5 10 15 20 25 30 35 P Q Equilibrium P QD QS $0 24 0 1 21 5 2 18 10 3 15 15 4 12 20 5 9 25 6 6 30 The  equilibrium  price  is  the  price  that   equates  quantity  supplied  with  quantity   demanded
  58. 58. D S $0.00 $1.00 $2.00 $3.00 $4.00 $5.00 $6.00 0 5 10 15 20 25 30 35 P Q P QD QS $0 24 0 1 21 5 2 18 10 3 15 15 4 12 20 5 9 25 6 6 30 The  equilibrium  quantity  is  the  quantity   supplied  and  quantity  demanded  at  the   equilibrium  price Equilibrium
  59. 59. $0.00 $1.00 $2.00 $3.00 $4.00 $5.00 $6.00 0 5 10 15 20 25 30 35 P Q D S Surplus  (A.K.A.  Excess  supply): A  surplus occurs  when  the  quantity  supplied is  greater  than  quantity  demanded Surplus Example:   If    P =    $5,   then QD =    9  lattes and QS =    25  lattes resulting  in  a   surplus  of  16  lattes
  60. 60. $0.00 $1.00 $2.00 $3.00 $4.00 $5.00 $6.00 0 5 10 15 20 25 30 35 P Q D S Facing  a  surplus,   sellers  try  to  increase   sales  by  cutting  price. This  causes   QD to  rise Surplus …which  reduces  the   surplus.       and  QS to  fall…     Surplus (A.K.A.  Excess  supply): A  surplus occurs  when  the  quantity  supplied  is  greater  than  quantity  demanded
  61. 61. $0.00 $1.00 $2.00 $3.00 $4.00 $5.00 $6.00 0 5 10 15 20 25 30 35 P Q D S Facing  a  surplus,   sellers  try  to  increase   sales  by  cutting  price. This  causes   QD to  rise  and  QS to  fall.     Surplus Prices  continue  to  fall   until  market  reaches   equilibrium.   Surplus  (A.K.A.  Excess  supply): A  surplus occurs  when  the  quantity  supplied  is  greater  than  quantity  demanded
  62. 62. $0.00 $1.00 $2.00 $3.00 $4.00 $5.00 $6.00 0 5 10 15 20 25 30 35 P Q D S Example:   If    P =    $1,   then QD =    21  lattes and QS =    5  lattes resulting  in  a   shortage  of  16  lattes Shortage Shortage (A.K.A.  Excess  Demand): A  shortage occurs  when  the  quantity  demanded is  greater  than  quantity  supplied  
  63. 63. $0.00 $1.00 $2.00 $3.00 $4.00 $5.00 $6.00 0 5 10 15 20 25 30 35 P Q D S Facing  a  shortage,   sellers  raise  the  price, causing  QD to  fall …which  reduces  the   shortage.       and  QS to  rise, Shortage Shortage (A.K.A.  Excess  Demand): A  shortage occurs  when  the  quantity  demanded is  greater  than  quantity  supplied  
  64. 64. $0.00 $1.00 $2.00 $3.00 $4.00 $5.00 $6.00 0 5 10 15 20 25 30 35 P Q D S Facing  a  shortage,   sellers  raise  the  price, causing  QD to  fall and  QS to  rise. Shortage Prices  continue  to  rise   until  market  reaches   equilibrium.   Shortage (A.K.A.  Excess  Demand): A  shortage occurs  when  the  quantity  demanded is  greater  than  quantity  supplied  
  65. 65. Exercise:  Surpluses  vs.  Shortages     • EXERCISE:  Are  the  following  statements  TRUE or  FALSE? • If  the  price  of  a  good  is  less  than  the  equilibrium  price,  there  is  surplus   and  the  price  will  fall.   • If  the  price  of  a  good  is  greater  than  the  equilibrium  price,  there  is   shortage  and  the  price  will  increase  
  66. 66. Three  Steps  to  Analyzing  Changes  in   Equilibrium   To  determine  the  effects  of  any  event:     1. Decide  whether  event  shifts  S curve,   D curve,  or  both.   2. Decide  in  which  direction curve  shifts.   3. Use  supply-­‐demand  diagram  to  see   how  the  shift  changes  eq’m P and  Q.  
  67. 67. The  Market  for  Lattes   P Q D1 S1 P1 Q1 Price  of   Lattes Quantity  of   Lattes In  equilibrium,  the  quantity   demanded  for  Lattes  equals   the  quantity  supplied  of   Lattes  and  the  market  price   and  quantity  of  Lattes  is   determined.  
  68. 68. STEP  1:     • D curve  shifts  because  price  of  tea   affects  the  demand  for  lattes.   • S curve  does  not  shift,  because   price  of  tea  does  not  affect  cost  of   producing  lattes.   STEP  2:     • D shifts  right because  a  higher   price  of  tea  makes  lattes  more   attractive  to  consumers. EXAMPLE  1:    A  Shift  in  Demand EVENT:    An  increase  in  price  of   tea. P Q D1 S1 P1 Q1 D2 P2 Q2 STEP  3:     • The  shift  causes  an  increase  in  price   and  quantity  of  Lattes  in  the   market.
  69. 69. P Q D1 S1 P1 Q1 D2 P2 Q2 Notice  that: When  P rises,  producers  supply   a  larger  quantity   of  Lattes,  even  though  the  S curve  has  not  shifted.   Always  be  careful  to   distinguish  between  a  shift  in  a   curve  and  a  movement  along   the  curve.   Always  be  careful  to   distinguish  between  a  shift  in  a   curve  and  a  movement  along   the  curve.   EXAMPLE  1:    A  Shift  in  Demand
  70. 70. STEP  1:     • S curve  shifts   because  the  event  affects  cost   of  production.   • D curve  does  not  shift,   because  input  costs  is  not  one   of  the  factors  that  affect   demand. STEP  2:     • S shifts  right because  event  reduces  cost,   making  production  more   profitable  at  any  given  price.   P Q D1 S1 P1 Q1 S2 P2 Q2 STEP  3:     • The  shift  causes  price  to  fall   and  quantity  to  rise. EVENT:    An  decrease  in  the  price   of  coffee  beans.   EXAMPLE  2:    A  Shift  in  Supply  
  71. 71. P Q D1 S1 P1 Q1 S2 D2 P2 Q2 STEP  1:     Both  curves  shift. STEP  2:     Both  shift  to  the  right.   STEP  3:     Q rises,  but  effect   on  P is  ambiguous:   If  demand  increases  more  than   supply,  P rises. EXAMPLE  3:    A  Shift  in  BOTH  Demand  and  Supply   EVENT:    An  increase  in  the  price  of   tea  AND  a  decrease  in  the  price  of   coffee  beans.  
  72. 72. P Q D1 S1 P1 Q1 S2 D2 P2 Q2 EXAMPLE  3:    A  Shift  in  BOTH  Demand  and  Supply   STEP  3  Continued:     But  if  supply  increases   more  than  demand,   P falls.   EVENT:    An  increase  in  the  price  of   tea  AND  a  decrease  in  the  price  of   coffee  machines.  
  73. 73. Exercise:  Demand  &  Supply • EXERCISE:  All  other  things  equal,  an  increase  in  the  supply  of  desert  safari  tours  will  tend   to  cause:   A. An  increase  in  the  equilibrium  price  and  quantity  of  desert  safari  tours. B. An  increase  in  the  equilibrium  price  and  a  decrease  in  the  equilibrium  quantity  of   desert  safari  tours. C. A  decrease  in  the  equilibrium  price  and  an  increase  in  the  equilibrium  quantity  of   desert  safari  tours. D. A  decrease  in  the  equilibrium  price  and  quantity  of  desert  safari  tours.  
  74. 74. Takeaways   • In  market  economies,  prices  adjust  to  balance   supply  and  demand.   • Equilibrium  prices  are  the  signals  that  guide   economic  decisions  and  thereby  allocate  scarce   resources.     Markets  are  usually  a  good  way  to  organize   economic  activity
  75. 75. MBEC 6001 Pre-Economics L3: The Costs of Production + Market Structures Part 1
  76. 76. Thought Experiment • Imagine that after graduating you decided to run your own business. • You must decide how much to produce, what price to charge, how many workers to hire, etc. • What factors should affect these decisions?  Your costs  How much competition you face • The level of competition will be determined by the type of market structure.
  77. 77. Market Structures
  78. 78. Market Structures • Markets may be characterized by different degrees of competition: High Competition Low Competition Perfect Competition Monopoly Oligopoly Monopolistic Competition Perfect Competition Monopolistic Competition Oligopoly Monopoly Number of Sellers Many Many Few One Products Sold by Firms Identical Differentiated (similar, but not identical) Differentiated or identical Unique Market Power Held by Firms No market power (Price Takers) Some market power Some market power Complete market power (Price Maker) Barriers to Entry Low to no barriers Low to no barriers Some barriers High barriers
  79. 79. Examples of Market Structures
  80. 80. Perfect Competition
  81. 81. 7 Characteristics of Perfect Competition 1. Many buyers and many sellers. 2. The goods offered for sale are largely the same. 3. Firms can freely enter or exit the market. Because of 1 & 2, each buyer and seller is a “price taker” – takes the price as given.
  82. 82. Decisions Faced by Perfectly Competitive Firm • Profit maximizing decision: How does a competitive firm determine the quantity that maximizes profits? • Shut down decision: When might a competitive firm shut down in the short run? • Exit decision: When might a competitive firm exit the market in the long run?
  83. 83. Profit Maximization
  84. 84. The Costs of a Competitive Firm • The total costs faced by different can be categorized into two types: Total Costs (TC) TC = FC +VC Fixed Costs (FC) Costs that do not vary with the quantity of output produced. Variable Costs (VC) Costs that vary with the quantity produced. E.g. Wages, costs of materials, etc. E.g. Rent, cost of equipment, loan payments
  85. 85. Fixed vs. Variable Costs 7 6 5 4 3 2 1 620 480 380 310 260 220 170 $100 520 380 280 210 160 120 70 $0 100 100 100 100 100 100 100 $100 0 TC VC FC Q $0 $100 $200 $300 $400 $500 $600 $700 $800 0 1 2 3 4 5 6 7 Q Costs FC VC TC Notice that the TC curve is parallel to the VC curve but is higher by the amount FC.
  86. 86. The Costs of a Competitive Firm • The per unit costs of production are given by:  Average total cost (ATC)  Average variable cost (AVC)  Average fixed cost (AFC) ∆TC ∆Q MC = TC Q ATC = VC Q AVC = FC Q AFC = • Marginal cost (MC) of production is given by the change in TC that arises from producing one more unit.
  87. 87. Initially when a firm increases its output, TC & VC start to increase at a diminishing rate. This is why marginal cost falls until it reaches a minimum. Then, as output rises, the marginal cost increases. Marginal Cost 620 7 480 6 380 5 310 4 260 3 220 2 170 1 $100 0 MC TC Q 140 100 70 50 40 50 $70 $0 $25 $50 $75 $100 $125 $150 $175 $200 0 1 2 3 4 5 6 7 Q Costs
  88. 88. Average Fixed Cost 100 7 100 6 100 5 100 4 100 3 100 2 100 1 14.29 16.67 20 25 33.33 50 $100 n/a $100 0 AFC FC Q Notice that AFC falls as Q rises: The firm is spreading its fixed costs over a larger and larger number of units. $0 $25 $50 $75 $100 $125 $150 $175 $200 0 1 2 3 4 5 6 7 Q Costs
  89. 89. Average Variable Cost 520 7 380 6 280 5 210 4 160 3 120 2 70 1 74.29 63.33 56.00 52.50 53.33 60 $70 n/a $0 0 AVC VC Q As Q rises, AVC may fall initially. In most cases, AVC will eventually rise as output rises. $0 $25 $50 $75 $100 $125 $150 $175 $200 0 1 2 3 4 5 6 7 Q Costs
  90. 90. Average Total Cost 88.57 80 76 77.50 86.67 110 $170 n/a ATC 620 7 480 6 380 5 310 4 260 3 220 2 170 1 $100 0 74.29 14.29 63.33 16.67 56.00 20 52.50 25 53.33 33.33 60 50 $70 $100 n/a n/a AVC AFC TC Q Notice that: ATC = AFC + AVC $0 $25 $50 $75 $100 $125 $150 $175 $200 0 1 2 3 4 5 6 7 Q Costs Usually, as in this example, the ATC curve is U- shaped.
  91. 91. Economies of Scale Economies of Scale: • Occur when an increase in a firm’s level of output lowers the average costs of production. • Results from: • Specialization of labour • Spreading of fixed costs • Bulk purchase of factor inputs Diseconomies of Scale: • Occur when an increase in a firm’s level of output raises the average costs of production. • Results from: • Bureaucracy • Higher labour costs • Spreading specialized resources too thin
  92. 92. The Various Cost Curves Together AFC AVC ATC MC $0 $25 $50 $75 $100 $125 $150 $175 $200 0 1 2 3 4 5 6 7 Q Costs
  93. 93. Use AFC = FC/Q Use AVC = VC/Q Use MC = Δ TC/ Δ Q Use ATC = TC/Q First, deduce FC = $50 and use TC = FC + VC 380 280 210 120 70 VC 80 63.33 16.67 480 6 56 5 77.50 25 310 4 86.67 53.33 33.33 260 3 220 2 $170 $70 1 n/a n/a n/a $100 0 MC ATC AVC AFC TC Q 100 40 $70 Exercise: The Costs of a Competitive Firm Fill in the below cost structure for a perfectly competitive firm:
  94. 94. Use AFC = FC/Q Use AVC = VC/Q Use MC = Δ TC/ Δ Q Use ATC = TC/Q First, deduce FC = $50 and use TC = FC + VC 380 280 210 160 120 70 $0 VC 80 63.33 16.67 480 6 76 56 20 380 5 77.50 52.50 25 310 4 86.67 53.33 33.33 260 3 110 60 50 220 2 $170 $70 $100 170 1 n/a n/a n/a $100 0 MC ATC AVC AFC TC Q 100 70 50 40 50 $70 Exercise: The Costs of a Competitive Firm Fill in the below cost structure for a perfectly competitive firm:
  95. 95. The Revenues of a Competitive Firm • Total revenue (TR) • Average revenue (AR) • Marginal revenue (MR) The change in TR from selling one more unit. ∆TR ∆Q MR = TR = P x Q TR Q AR = = P
  96. 96. Exercise: The Revenues of a Competitive Firm $50 $10 5 $40 $10 4 $10 3 $10 2 $10 $10 1 n/a $10 0 TR P Q MR AR $10
  97. 97. 23 $50 $10 5 $40 $10 4 $10 3 $10 $10 $10 $10 $10 2 $10 $10 1 n/a $30 $20 $10 $0 $10 0 TR = P x Q P Q ∆TR ∆Q MR = TR Q AR = $10 $10 $10 $10 $10 Notice that MR = P Exercise: The Revenues of a Competitive Firm
  98. 98. MR = P for a Competitive Firm • A competitive firm can keep increasing its output without affecting the market price. • So, each one-unit increase in Q causes revenue to rise by P, i.e., MR = P. MR = P is only true for firms in competitive markets.
  99. 99. Profit Maximization • What Q maximizes the firm’s profit? • To find the answer, “think at the margin”. ➢If increase Q by one unit, revenue rises by MR, cost rises by MC. • If MR > MC, then increase Q to raise profit. • If MR < MC, then reduce Q to raise profit.
  100. 100. Profit Maximization Rule: The profit-maximizing Q occurs when: MR = MC If this is not satisfied, choose Q where: MR ≈ MC but MR > MC
  101. 101. Profit Maximization 50 5 40 4 30 3 20 2 10 1 45 33 23 15 9 $5 $0 0 Profit = MR – MC MC MR Profit TC TR Q At any Q with MR > MC, increasing Q raises profit. 5 7 7 5 1 –$5 10 10 10 10 –2 0 2 4 $6 12 10 8 6 $4 $10 At any Q with MR < MC, reducing Q raises profit.
  102. 102. Shut-down & Exit Decision
  103. 103. Shutdown vs. Exit • Shutdown: A short-run (SR) decision not to produce anything because of market conditions. • Exit: A long-run (LR) decision to leave the market. • A key difference:  If firms shut down in the SR, they must still pay FC (Fixed costs).  If firms exit in the LR, they incur zero costs.
  104. 104. A Firm’s Short-run Decision to Shut Down • Cost of shutting down: Revenue loss = TR • Benefit of shutting down: Cost savings = VC (Variable Cost) (firms must still pay FC) • So, shut down if TR < VC • Divide both sides by Q: TR/Q < VC/Q • So, firm’s decision rule is: Shut down if P < AVC
  105. 105. The Irrelevance of Sunk Costs • Sunk cost: A cost that has already been committed and cannot be recovered • Sunk costs should be irrelevant to decisions; you must pay them regardless of your choice. • FC is a sunk cost: The firm must pay its fixed costs whether it produces or shuts down. • So, FC should not matter in the decision to shut down.
  106. 106. A Firm’s Long-Run Decision to Exit the Market • Cost of exiting the market: Revenue loss = TR • Benefit of exiting the market: Cost savings = TC (zero FC in the long run) • So, firm exits if TR < TC • Divide both sides by Q to write the firm’s decision rule as: Exit if P < ATC
  107. 107. A New Firm’s Decision to Enter the Market • In the long run, a new firm will enter the market if it is profitable to do so: if TR > TC. • Divide both sides by Q to express the firm’s entry decision as: Enter if P > ATC
  108. 108. Case Study: Near-empty Restaurants • To decide whether to stay open for lunch, the restaurant should rationally compare the benefits vs. the costs of closing for lunch (i.e. a temporary shut-down): • Cost of shutting down: Revenue lost = TR • Benefit of shutting down: Cost savings = VC (Only VC is relevant, FC is sunk) Shut down if revenues from lunch < variable cost Stay open if revenues from lunch > variable cost There are many restaurants that remain open during lunch hour even though the majority of their business occurs during the evening. What determines their decision to stay open for lunch?
  109. 109. Determining Profits & Loses
  110. 110. • Determine this firm’s total profit. • Identify the area on the graph that represents the firm’s profit. Q Costs, P MC ATC P = $10 MR 50 $6 A competitive firm Determining a Firm’s Profits
  111. 111. profit Q Costs, P MC ATC P = $10 MR 50 $6 A competitive firm Profit per unit = P – ATC = $10 – 6 = $4 Total profit = (P – ATC) x Q = $4 x 50 = $200 Determining a Firm’s Profits
  112. 112. • Determine this firm’s total loss, assuming AVC < $3. • Identify the area on the graph that represents the firm’s loss. Q Costs, P MC ATC A competitive firm $5 P = $3 MR 30 Determining a Firm’s Loss
  113. 113. loss MR P = $3 Q Costs, P MC ATC A competitive firm loss per unit = $2 Total loss = (ATC – P) x Q = $2 x 30 = $60 $5 30 Determining a Firm’s Loss
  114. 114. Exercise: Determining a Firm’s Loss A. What is the firm’s profit maximizing quantity? B. What is the total profits at this profit maximizing quantity?
  115. 115. Conclusion: The Efficiency of a Competitive Market • Profit-maximization: MC = MR • Perfect competition: P = MR • So, in the competitive eq’m: P = MC • Recall, MC is cost of producing the marginal unit. P is value to buyers of the marginal unit. • Therefore, the competitive equilibrium is efficient.
  116. 116. MBEC 6001 Pre-Economics L4: Market Structures Part 2 Monopoly
  117. 117. Introduction • A monopoly is a firm that is the sole seller of a product without close substitutes. • The key difference between perfect competition and monopoly: A monopoly firm has market power, the ability to influence the market price of the product it sells. In contrast, a competitive firm has no market power.
  118. 118. Characteristics of a Monopoly Only one supplier Unique good High barriers to entry Market Power
  119. 119. What Gives Rise to Monopolies?
  120. 120. Why Monopolies Arise The main cause of monopolies is barriers to entry – other firms cannot enter the market. Three sources of barriers to entry: 1. A single firm owns a key resource. E.g., DeBeers owns most of the world’s diamond mines. 2. The govt gives a single firm the exclusive right to produce the good. E.g., patents, copyright laws
  121. 121. Case Study: The History of De Beers & Diamonds • The Incredible Story of How De Beers Created and Lost the Most Powerful Monopoly Ever
  122. 122. Why Monopolies Arise 3. Natural monopoly: a single firm can produce the entire market Q at lower cost than could several firms. Q Cost ATC 1000 $50 Example: 1000 homes need electricity Electricity ATC slopes downward due to huge FC and small MC. ATC is lower if one firm services all 1000 homes than if two firms each service 500 homes. 500 $80 This is the power of economies of scale!
  123. 123. Exercise: Types of Monopoly • EXERCISE: Which of the following results in a natural monopoly? A. When the government grants a firm the exclusive right to supply a good or service. B. When a single firm is able to produce at a lower average cost than two or more firms. C. When there is a government license is required before a firm can sell a good or service. D. When a firm own a key resource.
  124. 124. Monopolist’s D-Curve
  125. 125. Monopoly vs. Competition: Demand Curves • In a competitive market, the market demand curve slopes downward. • But the individual demand curve for any firm’s product is horizontal at the market price. • The firm can increase Q without lowering P, so for the competitive firm, MR = P D P Q A competitive firm’s demand curve
  126. 126. Monopoly vs. Competition: Demand Curves • A monopolist is the only seller, so it faces the market demand curve. • To sell a larger Q, the firm must reduce P. • Thus, for the monopoly, MR ≠ P. D P Q A monopolist’s demand curve
  127. 127. Q P TR AR MR 0 $4.50 1 4.00 2 3.50 3 3.00 4 2.50 5 2.00 6 1.50 n.a. • Suppose that Coffee Bean is the only seller of cappuccinos in DAH. • The table shows the market demand for cappuccinos. • Fill in the missing spaces of the table. • What is the relation between P and AR? Between P and MR? Example: A Monopolist’s Revenues
  128. 128. • Here, P = AR, same as for a competitive firm. • However, MR < P, whereas MR = P for a competitive firm. 1.50 6 2.00 5 2.50 4 3.00 3 3.50 2 1.50 2.00 2.50 3.00 3.50 $4.00 4.00 1 n.a. 9 10 10 9 7 4 $ 0 $4.50 0 MR AR TR P Q –1 0 1 2 3 $4 Example: A Monopolist’s Revenues
  129. 129. Example: A Monopolist’s Revenues -3 -2 -1 0 1 2 3 4 5 0 1 2 3 4 5 6 7 Q P, MR MR $ Demand curve (P) 1.50 6 2.00 5 2.50 4 3.00 3 3.50 2 4.00 1 $4.50 0 MR P Q –1 0 1 2 3 $4 At any Q, the MR < P.
  130. 130. Understanding the Monopolist’s MR • Increasing Q has two effects on revenue:  Output effect: higher output raises revenue  Price effect: lower price reduces revenue • To sell a larger Q, the monopolist must reduce the price on all the units it sells. Hence, MR < P for a monopolist.
  131. 131. Profit Maximization
  132. 132. Profit-Maximization • Like a competitive firm, a monopolist maximizes profit by producing the quantity where MR = MC. • Once the monopolist identifies this quantity, it sets the highest price consumers are willing to pay for that quantity. • It finds this price from the D-curve.
  133. 133. Profit-Maximization 1. The profit- maximizing Q is where MR = MC. 2. Find P from the demand curve at this Q. Quantity Costs and Revenue MR D MC Profit-maximizing output P Q
  134. 134. The Monopolist’s Profit As with a competitive firm, the monopolist’s profit equals: (P – ATC) x Q Quantity Costs and Revenue ATC D MR MC Q P ATC markup Notice that the monopolist charges a markup of price over marginal cost: P > MC = MR MC
  135. 135. The Monopolist’s Profit The monopolist’s profit equals: (P – ATC) x Q = (40 – 30) x 50 = $500 Quantity Costs and Revenue ATC D MR MC 50 40 30
  136. 136. Exercise: The Monopolist’s Profit • Identify each of the following: A.The level of output B.The price C.The total revenue D.The total costs E.The profit or loss
  137. 137. Price Discrimination • Price discrimination: selling the same good at different prices to different buyers. • The characteristic used in price discrimination is willingness to pay (WTP):  A firm can increase profit by charging a higher price to buyers with higher WTP. • In the real world, firms divide customers into groups based on some observable trait related to WTP e.g. age, occupation, gender, etc.
  138. 138. Examples of Price Discrimination Movie tickets Discounts for seniors, students, and people who can attend during weekday afternoons. They are all more likely to have lower WTP than people who pay full price on weekend nights. Airline prices Discounts for weekend stayovers help distinguish business travelers, who usually have higher WTP, from more price-sensitive leisure travelers.
  139. 139. Monopolistic Competition
  140. 140. Introduction Two extremes market structures:  Perfect competition: many firms, identical products  Monopoly: one firm, unique product In between these extremes, lies imperfect competition:  Oligopoly: only a few sellers offer similar or identical products.  Monopolistic competition: many firms sell similar but not identical products.
  141. 141. Monopolistic Competition Characteristics:  Many sellers  Product differentiation  Free entry and exit Examples:  Apartments  Books  Bottled water  Clothing  Fast Food
  142. 142. profit ATC P A Monopolistically Competitive Firm Earning Profits in the Short Run • This firm faces a downward- sloping D curve. • At each Q, MR < P (The MR cure is below the D-curve). • To maximize profit, firm produces Q where MR = MC and chooses P using the D curve. • For this firm, P > ATC at the output where MR = MC. • Therefore, it is making profits in the short-term. Quantity Price ATC D MR MC Q The D-curve is flatter than for a monopoly.
  143. 143. losses A Monopolistically Competitive Firm with Losses in the Short Run • For this firm, P < ATC at the output where MR = MC. • The best this firm can do is to minimize its losses. Quantity Price ATC Q P ATC MC D MR
  144. 144. Advertising & Branding • In monopolistically competitive markets, product differentiation & mark-up pricing lead naturally to the use of advertising. • In general, the more differentiated the products, the more advertising firms use. • Firms with brand names usually spend more on advertising & charge higher prices.
  145. 145. Case Study: Advertising in Monopolistic Competition • Samsung Galaxy: Join the Flip Side • Samsung Galaxy: Growing Up
  146. 146. Exercise: Monopolistic Competition • EXERCISE: Which of the following statements about monopolistic competition is FALSE? A. Products are similar, but differentiated. B. Firms charge a markup of price over marginal cost. C. Firms face a downwards sloping D-curve. D. Firms face high barriers to entry.
  147. 147. Review of Market Structures
  148. 148. Comparison of Market Structures Perfect Competition Monopolistic Competition Monopoly Number of Sellers Many Many One Free entry/exit Yes Yes No Long-run economic profits Zero Zero Profit The products firm sell Identical Differentiated One unique product Firms have market power No (Price-takers) Yes Yes (Price-maker) Firm’s D-curve Horizontal Downward sloping Downward sloping
  149. 149. Determining Profits or Losses • In all three markets, four main curves used in the analysis: 1. MC curve (upward-sloping); 2. ATC curve (u-shape); 3. MR curve; 4. Firm’s D-curve. • To determine a firm’s profit or losses: 1. First, identify the profit maximizing quantity (Q) where MR=MC 2. Next, identify the price (P) set by the firm given Q 3. Finally, compare the vertical distance between P and where the Q hits the ATC curve ➢If P>ATC → PROFITS ➢If P<ATC → LOSSES
  150. 150. profit Q Costs, P MC ATC P MR 50 ATC A competitive firm Perfect Competition Total profit = height * width =Profit per unit * No. of units =(P-ATC) *Q Profit Max: MR= MC Perfect Comp.: P=MR (Shown by horizontal D- curve being the same as the MR curve)
  151. 151. Monopoly Quantity Costs and Revenue ATC D MR MC Q P ATC A Monopoly Total profit = height * width =Profit per unit * No. of units =(P-ATC) *Q Profit Max: MR= MC Monopolistic Comp: P>MR (Shown by horizontal D- curve being higher than the MR curve)
  152. 152. profit ATC P Monopolistic Competition Quantity Price ATC D MR MC Q Total profit = height * width =Profit per unit * No. of units =(P-ATC) *Q Profit Max: MR= MC Monopolistic Comp: P>MR (Shown by horizontal D- curve being higher than the MR curve) A Monopolistically competitive Firm
  153. 153. MBEC 6001 Pre-Economics L5: Public Goods, Public Expenditures & Common Resources
  154. 154. Introduction • We consume many goods without paying: parks, national defense, clean air & water. • When goods have no prices, the market forces that normally allocate resources are absent. • The private market may fail to provide the socially efficient quantity of such goods. • In this case, governments can sometimes improve market outcomes.
  155. 155. Types of Goods
  156. 156. Important Characteristics of Goods • A good is excludable if a person can be prevented from using it.  Excludable: Cinema tickets, airplane tickets  Not excludable: Street lighting, national defense • A good is rival in consumption if one person’s use of it diminishes others’ use.  Rival: Fuel, food  Not rival: Museums, paintings
  157. 157. The Different Types of Goods • Using these two characteristics, most goods can be classified into four categories: Rival in Consumption? Yes No Excludable? Yes Private Goods Clothing Club Goods Cable TV No Common Resources The environment Public Goods Clean air
  158. 158. The Different Types of Goods Private Goods Jeans Hamburgers Contact lenses Public Goods Fire works Mosquito protection Traffic control Club Goods Private parks Wifi Computer software Common Goods Public roads Fish in the Ocean Public schooling Excludable & Rival in consumption Non-excludable & non-rival in consumption Excludable, but non-rival in consumption Non-excludable, but rival in consumption
  159. 159. Public Goods and Common Resources
  160. 160. Public Goods • Public goods are difficult for private markets to provide because of the free-rider problem.  Free-rider: A person who receives the benefit of a good but avoids paying for it. • If a good is not excludable, people have incentive to be free riders, because firms cannot prevent non-payers from consuming the good. • Result: The good is not produced, even if buyers collectively value the good higher than the cost of providing it. • There is a need for government to provide the good.
  161. 161. The Free-Rider Problem • https://www.youtube.com/watch?v=Uo51GDk8G1Q
  162. 162. Common Resources • Like public goods, common resources are not excludable:  Cannot prevent free-riders from using  Little incentive for firms to provide  There is a need for government to provide the good. • An additional problem with common resources is that they are rival in consumption:  Each person’s use reduces others’ ability to use it  There is a need for government to ensure that the good is not overused.
  163. 163. Tragedy of the Commons • https://www.youtube.com/watch?v=CxC161GvMPc
  164. 164. Public Goods and Common Resources • For both public goods & common resources, externalities arise because something of value has no price attached to it. • In this case, private decisions about consumption and production in the market can lead to an inefficient outcome. In other words, there is a market failure. • Therefore, there is a role for governments to step in to potentially raise economic well-being. An externality is the economic impact of consuming or producing a good on a third party who isn’t connected to the good (E.g. positive externality (clean air), negative externality (pollution)).
  165. 165. Reading • Textbook: Mankiw, N. (2009). Principles of economics (5th ed.). Mason, OH: Thomson South-Western Chapter 11

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